Purpose: This IRM provides guidance and technical information for the Foreign Investment in Real Property Tax Act.

Audience: The primary users of this IRM are employees, management and executives of the WEIIC Practice Area in LB&I.

Policy Owner: LB&I Policy under the Strategy, Policy and Governance office in the Assistant Deputy Commissioner Compliance Integration organization.

Program Owner: Director, Withholding Exchange & International Individual Compliance.

Primary Stakeholders: IRS examiners, Wage and Investment (W&I) Division, Ogden Accounts Management.

Foreign persons who dispose of U.S. real property interest after June 18, 1980 must treat any gain or loss from the disposition as if such gain or loss were income effectively connected with a U.S. trade or business [See IRC 897].

U.S. Real Property Interest (USRPI) includes:

USRPI includes any interest, except an interest solely as a creditor. USRPI also includes associated personal property. Below are examples of USRPI:

Dispositions of interests in pass-through entities are taxed to the extent the gains are attributable to USRPIs held by the entities [See IRC 897(a)]. These entities include partnerships, trusts, and estates. Gains or losses pass through to partners or beneficiaries.

Any transfer considered a "disposition" under any section of the code and regulations is considered a disposition under IRC 897. Under certain circumstances, transfers otherwise qualifying for nonrecognition treatment may be taxed under IRC 897. Dispositions may include the following:

A withholding obligation for dispositions of a USRPIs is required under IRC 1445 as of January 1, 1985. IRC 1461 makes the transferee liable for the tax that must be deducted and withheld under IRC 1445.

IRC 1445 and applicable regulations authorize the Service to reduce or eliminate the withholding amount. Rev. Proc. 2000-35 provides procedures for obtaining a withholding certificate to reduce or eliminate the withholding amount.

A withholding certificate only adjusts a withholding obligation to correspond with the probable tax liability arising from a transfer. It does not resolve substantive issues that may arise concerning the transfer.

If the application for a withholding certificate is submitted to the Service on or before the date of transfer, and the application is pending, the transferee need not pay over the amount required to be withheld immediately. Such a transferee must pay the withheld amount by the 20th day after the Service mails a copy of the withholding certificate or a denial.

Examiners should do the following when examining dispositions of USRPIs:

IRC 897(i) allows foreign corporations to be taxed as domestic corporations for FIRPTA purposes only. To make an IRC 897(i) election, a foreign corporation must:

Under IRC 897(i) the electing foreign corporation is treated as a USRPHC. Its stock is therefore a USRPI and subject to FIRPTA on its disposition.

While examining the Form 1120F ( U.S. Income Tax Return of a Foreign Corporation), the examiner should do the following:

The examiner should review the tax return for attachments required by Reg 1.897–5T(d)(1)(iii) and Notice 89–57. These attachments must include the following:

To decide if FIRPTA applies, the examiner should determine whether a domestic corporation is a USRPHC. If a domestic corporation is a USRPHC (or was one in the preceding five- year period), its stock is a USRPI.

A USRPHC is a domestic corporation whose USRPI percentage equaled 50 percent or more anytime within the preceding five-year period. In general, the formula is:

Figure 4.61.12-1

The graphic shows the formula to calculate the United States Real Property Holding Company Percentage. The United States Real Property Holding Company Percentage equals the fair market value of United States Real Property Interests divided by the sum of the fair market value of United States Real Property Interests, the fair market value of Foreign Real Property Interests, and the fair market value of Trade or Business Assets.

Please click here for the text description of the image.

A foreign corporation is generally a USRPHC only for purposes of determining whether a corporation owning interests directly in the foreign corporation is a USRPHC [See Treas. Reg. 1.897–2(e)(1)].

Trade or business assets are assets other than USRPIs that are:

A corporation is presumed not to be a USRPHC when the book value of its USRPIs is 25 percent or less than the book value of its assets on the determination date. Book value is the value carried on the corporation’s financial statements as determined by Generally Accepted Accounting Principles (GAAP).

Look-through rules apply to the determination of USRPHC status. They are as follows:

Dates for determining USRPHC status are as follows:

USRPHC status may be terminated by either of two ways.

To avoid FIRPTA, a foreign person disposing of interest in a domestic corporation must establish the corporation’s non-USRPHC status as of the disposition date. This is done by:

FIRPTA may apply at the shareholder level to any distribution made by a domestic corporation that is a USRPHC. FIRPTA will apply at the corporate level to distributions of USRPIs by a foreign corporation.

Dividends received by foreign shareholders are subject to tax under other Code provisions, accordingly FIRPTA is not applicable. The effect of Code provisions may be modified by treaty and as modified are not altered by the corporation’s USRPHC status.

A foreign shareholder may receive a nonliquidating capital gain distribution from a USRPHC if the value of the distribution exceeds the foreign shareholder’s adjusted basis in its stock. The gain may be subject to FIRPTA tax unless the shares are regularly traded on an established securities market and the foreign person did not own more than 5% of the shares during the relevant period.

A foreign shareholder receiving a liquidating distribution from a USRPHC is deemed to have disposed of its stock. The resulting gain is subject to FIRPTA tax unless the foreign shareholder is a corporation, and the liquidation is an IRC 332(a) liquidation [See Treas. Reg. 1.897–5T(b)(3)(iv)(A)], or the shares are regularly traded on an established securities market and the foreign person did not own more than 5% of the shares during the relevant period.

The examiner should request all books and records relating to the determination of USRPHC status. This may include (but is not limited to) the following:

The examiner should remain aware of the five-year taint that USRPHC status may entail. Preceding years’ USRPHC status may, therefore, affect the taxation of current distributions.

When property distributed by a foreign corporation is a USRPI, FIRPTA applies to the foreign corporation, not to the shareholder.

If a foreign corporation disposes of a USRPI, the examiner should consider the importance of the following:

If a foreign corporation distributes a USRPI to its shareholders, it should recognize gain unless:

Partnerships with foreign partners have three types of transactions that trigger FIRPTA consequences:

Dispositions of USRPIs by the partnership—A foreign partner’s share of gain or loss from a partnership disposition of a USRPI is treated as a direct disposition of the USRPI by the foreign partner.

Dispositions of partnership interests by foreign partners—

Contributions to and distributions by a partnership— Contributions to and distributions by partnerships are normally not taxable events. Non-recognition may allow avoidance of IRC 897. IRC 897(e)(2) authorizes the Service to issue anti-avoidance regulations. Additionally, under IRC 897(g) if money or property is exchanged for "all or part" of a foreign partner’s interest in a partnership gain or loss is recognized to the extent attributable to a USRPI. Under Treas. Reg. 1.897–6T, the exchange of a USRPI for an interest in a partnership will receive non-recognition treatment pursuant to Section 721 only to the extent that a disposition of the partnership interest will be subject to U.S. taxation under Section 897(g).

FIRPTA withholding rules in the partnership context.

Disposition of a partnership interest may result in the following consequences:

IRC 1446 imposes a withholding obligation on all partnerships (except those treated as corporations under IRC 7704 ) that have "effectively connected taxable income" allocable to a foreign partner. IRC 1446 requires withholding at the time the income is earned and regardless of whether distributions are actually made to foreign partners. "Effectively connected taxable income" includes gains or losses from dispositions of USRPIs [See Treas. Reg. 1.1446-2(b)(2)(ii)]. IRC 1446 withholding generally preempts the IRC 1445 withholding rules for domestic partnerships [See Treas. Reg. 1.1446-3(c)(2)(i)]. The tax is reported on Form 8804, Annual Return for Partnership Withholding Tax (Section 1446).

A foreign partnership is a foreign person for purposes of FIRPTA withholding. The buyer of a USRPI from a foreign partnership must withhold 15 percent of the amount realized. The foreign partnership is then allowed to credit the amount withheld under IRC 1445 against its IRC 1446 withholding liability for the year only to the extent such amount is allocable to foreign partners [See Treas. Reg. 1.1446-3(c)(2)(ii)].

A real estate investment trust (REIT) is a conduit entity. In general, it is not taxed on ordinary income and capital gains distributed to its owners if it distributes 95 percent of such income. REIT is taxed at corporate rates. REIT is entitled to a dividend paid deduction. Shareholders treat a dividend from a REIT as either a capital gain or ordinary dividend, depending on the REIT’s designation.

IRC 897(h) provides rules that apply to distributions made by REITs to foreign shareholders. Foreign shareholders must treat the distribution as an IRC 897 gain to the extent the distribution is attributable to gain realized by the REIT from the sale or exchange of a USRPI. Solely for purposes of IRC 1445 withholding, the largest amount of a post-March 7,1991 distribution that could be designated as a capital gain dividend under IRC 857(b)(3)(c) will be treated as actually designated capital gain dividend.

Under IRC 897(c)(1), a REIT normally qualifies as a USRPHC, and an interest in a REIT is generally a USRPI, however, under IRC 897(h)(2) an interest in a domestically controlled REIT is not a USRPI. Therefore, a foreign shareholder disposing of REIT stock generally must recognize gain from the disposition of a non-domestically controlled REIT under IRC 897.

To determine whether IRC 897 and IRC 1445 apply to a distribution from a REIT, the examiner should review the following:

Some U.S. tax treaties provide specific rules for certain REIT distributions. In such circumstances, these will override any code provisions.

IRC 1001 provides rules for determining gain on the sale or other disposition of property. Gain is equal to the amount realized minus the adjusted basis of the property. The amount realized is the sum of the following:

Gain on the disposition of property is fully taxable unless the Code provides an exception. The following are among the provisions of the Code that provide exceptions from gain recognition:

IRC 897 provides additional requirements for nonrecognition treatment. IRC 897(d) provides that a foreign corporation must generally recognize gain on a distribution of a USRPI. This rule applies also to a distribution in liquidation or redemption. Gain need not be recognized if:

Under IRC 897(e), the non-recognition provisions generally apply to the sale or exchange of a USRPI only if it is exchanged for an interest that would be subject to the U.S. taxation [See Treas. Reg. 1.897–5T and 6T for implementing regulations].

Nonresident aliens are generally not subject to tax on U.S. source capital gains. Their capital gains are taxed only if the gains are effectively connected income or they have been present in the United States for 183 days or more during the taxable year in which the property is sold or exchanged. USRPIs are generally capital assets. Consequently, absent FIRPTA, the dispositions of USRPIs would generally not be subject to tax.

Absent anti-abuse rules, foreign corporations could avoid FIRPTA by exchanging USRPIs for non-USRPIs or stock. Subsequent exchanges would not be subject to tax unless the property received is:

IRC 897(d) and IRC 897(e) are aimed at preventing foreign corporations from attempting to purge a USRPI's FIRPTA taint by exchanging a USRPI for non-USRPI.

Examiners should review tax returns for nonrecognition transactions. Generally, taxpayers must file information statements with the tax return when they claim nonrecognition treatment.

Many foreign corporations used nonrecognition provisions to domesticate in 1986 and 1987. This was motivated by unfavorable changes in tax laws that became effective after 1986. Examiners should check foreign-owned domestic corporations for previous reorganizations. Examiners should check domestic corporations owning real property for foreign ownership. Although the statute of limitations may have expired, tax attributes can still be adjusted. This includes the basis of property and net operating losses.

The nonrecognition provisions of Subchapter C are very stringent. Failure to meet requirements can result in gain recognition to the transferor. It can also result in withholding at the source. Nonrecognition transactions must also meet FIRPTA requirements to avoid gain recognition and withholding.

Reorganizations qualify for nonrecognition treatment only if they meet the following requirements:

Distributions of property to persons not party to reorganizations do not qualify for nonrecognition treatment. Additionally, qualifying for nonrecognition treatment under FIRPTA requires the following:

IRC 897(e)(1) applies to the exchange of a USRPI by a foreign corporation for stock of another foreign corporation pursuant to certain reorganizations. These reorganizations include reorganizations under IRC 368(a)(1)(B), (C), (D) or (F). These reorganizations are generally taxable under FIRPTA if the foreign corporation did not make an IRC 897(i) election. [See Treas. Reg. 1.897–6T for exceptions to gain recognition for certain foreign to foreign exchanges of a USRPI for a non USRPI.]

To qualify for nonrecognition treatment, Type A, B, C, D, F and G reorganizations must pass muster under both Subchapter C and FIRPTA.

IRC 351 transfers of USRPIs for foreign corporation stock generally do not qualify for nonrecognition treatment unless:

IRC 351 transfers of USRPIs for domestic corporation stock qualify for nonrecognition treatment if:

Under FIRPTA, an interest in a "mine, well or other natural deposit" located in the United States is a USRPI. Examiners may encounter the following types of interests:

All of the interests above are USRPIs except for the production payment interest. The production payment interest is a USRPI if it conveys a right to share in the appreciation in value of the property. Examiners should review the production payment interest to determine whether it is a USRPI. In doing so, examiners should inspect the following:

If a production payment interest is a USRPI, its disposition is subject to FIRPTA.

Examiners should review debt instruments held by foreign taxpayers. Debt instruments may have contingent interest features. These features may provide for interest if U.S. real property appreciates in value. Under FIRPTA, these types of debt instruments (called shared appreciation loans) qualify as USRPIs. Therefore, dispositions of these debt instruments are taxable under IRC 897 [See Treas. Reg. 1.897–1(d)].

Examiners should review debt instruments with contingent interest features. Taxpayers may attempt to use debt instruments with contingent interest features to avoid IRC 897. In such an arrangement, a foreign taxpayer makes a loan to a domestic borrower. It does so rather than obtain a direct interest in a USRPI. The USRPI is owned by a domestic borrower who is the debtor with respect to the shared appreciation loan. The domestic borrower realizes a gain on the sale of the property. Part of the gain is paid to the foreign lender as contingent interest in satisfaction of a debt instrument. The "contingent interest" received by the foreign taxpayer is gain subject to taxation under IRC 897(a) [See also IRC 871(h)(4) for the exclusion of contingent interest from portfolio debt exception].

Examiners should review the debt instrument and related documents for the following:

Examiners should examine the relationships of the parties involved for any activities relating to the USRPI.

Examiners should determine how payments are made on the debt instrument and whether the payments are reported consistently from year to year.

Examiners should contact the Office of Associate Chief Counsel (International) if they encounter problems in this area.

Examiners should scrutinize the basis of USRPIs disposed of by foreign taxpayers.

Foreign taxpayers should reduce the basis of USRPIs by depreciation allowable, not depreciation taken.

Nonresident aliens or foreign corporations may earn gross income from the rental of U.S. real property. If not effectively connected to a U.S. trade or business, the income is subject to 30 percent tax. Under IRC 871(d), nonresident aliens who derive gross income from U.S. real property that is not "effectively connected income" may elect to treat such income as if it were "effectively connected income." Likewise, under IRC 882(d), foreign corporations who derive gross income from U.S. real property that is not "effectively connected income" may elect to treat such income as if it were "effectively connected income." This election allows deductions if and to the extent related to the "effectively connected income."

Under IRC 874, nonresident aliens must file a return to take any deductions.

Foreign taxpayers who have made an election to treat income from real property as effectively connected income may receive a positive basis adjustment for carrying charges such as:

Real estate taxes, mortgage interest or other carrying charges are generally not connected with "effectively connected income" , unless an election under IRC 874(d) or IRC 882(d) is made. Foreign persons cannot make IRC 871(d) or IRC 882(d) elections for a taxable year when no income is derived from the property. Consequently, foreign persons are not allowed deductions of expenses from U.S. real property that are not otherwise "effectively connected" for such taxable year. Because the expenses are not otherwise deductible, they cannot be capitalized [See Rev. Rul. 91–7].

This guidance provides instructions with respect to managing issues under IRC 1445 related to certain timeshare arrangements. Specifically, this applies to examinations of LB&I taxpayers that failed to file Forms 8288, 8288-A or 8288-B for personal use timeshare "upgrade" transactions that result in no realized gain to nonresident alien individuals ("NRAs"). See Exhibit 4.61.12-3 below for details.

All information contained on Form 8288, U.S. Withholding Tax Return for Certain Dispositions by Foreign Persons

All information contained on Form 8288–A, Statement of Withholding on Certain Dispositions by Foreign Persons

Information contained on Form 8288–B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests. This includes the following information:

Asset ownership

Property addresses

Individual’s mailing address

Assessed valuations

Current market values

Recent property sales and deed transfers

Names and addresses of owners

Dates properties were sold

Names and addresses of sellers

Sales prices

Descriptions of properties

Name and home address of timeshare owner.

Unit number/address of the disposed timeshare interest.

Date of the purchase of the disposed timeshare interest.

Purchase price of disposed timeshare interest.

Date of the upgrade transaction.

Fair market value of the disposed timeshare interest.

Value of the disposed timeshare interest credited to the NRA.

Purchase price of the newly purchased timeshare interest.

Unit number/address of the newly purchased timeshare interest, as well as the description (and amount) of any other consideration (for example, credits or points) exchanged in the upgrade transaction.

Mineral Fee Interest. Mineral fee interests are direct interests in oil and gas underlying particular tracts of land. They are frequently severed from the rights to the surface of the land. In these situations, mineral fee interest owners have implied rights to use the surface of the land to develop and produce the underlying oil and gas.

Operating Interest. Operating or working interests are also direct ownership interests in the oil and gas. Operating or working interests are burdened with the cost of developing and operating the property.

Landowner’s Royalty Interest. A landowner’s royalty interest: (1) Entitles the owner to a specified fraction of the property’s total production; (2) Is not burdened with the cost of developing and operating the property; (3) Is created by the mineral fee owner’s assigning or reserving the interest.

Overriding Royalty Interest. An overriding royalty interest: (1) Is a right relating to oil and gas in place; (2) Entitles the owner to a specified fraction of the property’s total production; (3) Does not burden the owner with the cost of developing and operating the property; (4) Is created out of an operating interest and ends with the operating interest.